When accepting a subordinated seller note, we are taking on significant credit risk if the buyer over-leverages the business. How do we negotiate a leverage-based pricing grid to protect our deferred cash?

Question

Tyler Smith · Accepted Answer

When you accept a subordinated seller note, you are taking on significant credit risk. If the buyer takes on too much senior debt to fund other acquisitions post-close, the risk of default on your seller note skyrockets.

To protect your cash, you can negotiate a leverage-based pricing grid for your seller note. Under this structure, the interest rate on your note is not static. Instead, it scales upward if the company's total leverage ratio exceeds a defined threshold.

This provides a strong financial disincentive for the buyer to over-leverage the business and deplete its cash reserves.

During your quarterly review of the company's financial performance, you can monitor this ratio using the post-closing information rights you negotiated. If the buyer chooses to operate with high leverage, you are compensated for that increased risk with a higher interest yield.

Use your structured thinking time to model these leverage tiers before final negotiations. This dynamic pricing model aligns the buyer's capital structure with your risk tolerance and secures your deferred compensation.